Month: February 2015

Where the IRS will Likely Look in Latin America: Country Specific Tax Returns filed by U.S. Individual Taxpayers – Latin America (Excluding Mexico)

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The prior post asked the “question”: Where the IRS will likely look overseas: USCs are Millions Yet U.S. Tax Returns are Just a Few Hundred Thousand [?]

As a continuation of the prior post, some further analysis by geographical region is provided here.  This post is focused on Latin American countries Central America Mapwhere U.S. citizens, lawful permanent residents (“LPRs”) or other individuals who may be U.S. tax residents (e.g., those individuals who make an election to be treated as a “U.S. person” for federal income tax purposes) are or are not filing U.S. tax returns.  For an important discussion of LPRs, see,  Who is a “long-term” lawful permanent resident (“LPR”) and why does it matter?

The IRS provides detailed statistical information on tax returns filed; how many, and in various groupings and from various locations.  One such grouping by the IRS office of statistics, is by those individuals who filed tax returns which contained the “foreign earned income exclusion” which is reported on Form 2555: Foreign-Earned Income Exclusion, Housing Exclusion, and Housing Deduction.

See, The Foreign Earned Income Exclusion is Only Available If a U.S. Income Tax Return is File

The IRS reports that less than 15,000 tax returns were filed from all of of Latin/South America (excluding Mexico); for the year 2011, the last year they reported these statistics reflecting the foreign earned income exclusion.  One of the more surprising statistics is that according to the U.S. Department of State, some 120,000 U.S. citizens reside in Costa Rica alone, yet only about 2,100 U.S. income tax returns were filed from Costa Rica with the foreign earned income exclusion.South America Map

Indeed, according to the U.S. federal government’s own numbers, there are approximately more than 8 times the number of U.S. citizens, simply living in Costa Rica  (approx. 120,000) compared to the total number of U.S. tax returns (14,732) filed from all of the Latin/South American countries (excluding Mexico) that had the foreign earned income exclusion.

Similarly, Panama according to the U.S. Department of State, has ” . . . About 25,000 American citizens reside in Panama, many retirees from the Panama Canal Commission and individuals who hold dual nationality. There is also a rapidly growing enclave of American retirees in the Chiriqui Province in western Panama.”  However, only about 1,200 U.S. income tax returns were filed from Panama with the foreign earned income exclusion.

Each Latin/South America country from which the number of U.S. tax returns were filed in 2011, with the foreign earned income exclusion is set out below:

 

Latin/South America, total 14,732
   Argentina 986
   Brazil 3,351
   Chile 1,383
   Colombia 1,524
   Costa Rica 2,147
   Panama 1,187
   Peru 1,098
   Venezuela 778
   Other Latin and South American countries 2,280

 

This analysis is surely the type of analysis being conducted by the IRS which will be supplemented with information as they start receiving financial account and income information from countries and their financial institutions around the world (not just Latin America) from FATCA and the IGAs.  See,  Part 1- Unintended Consequences of FATCA – for USCs and LPRs Living Outside the U.S.

Three key observations about the above analysis.

First, there are many U.S. citizens residing overseas who have (a) income below certain thresholds, (b)  are simply retired or unemployed – and have no foreign earned income, and/or (c) are not aware of how they can benefit from the foreign income exclusions; and therefore are not filing U.S. tax returns with the foreign earned income exclusion.  However, the disproportionate number of U.S. citizens living throughout Latin America compared with the tax returns that are filed in this category is a strong indicator of low compliance by these taxpayers.  The IRS will surely take note of this key consideration.

Second, the above numbers do not try to identify the number of LPRs who are residing in these Latin American countries who are also not filing U.S. income tax returns.  There are some 13-14 million LPRs.  See, What are the Number of LPRs who Leave U.S. Annually without filing Form I-407 – Abandonment?

Third,  Latin America has the largest percentage of the population throughout the world where more U.S. citizens reside.  See, a 2012 proposal I prepared for the State Bar of California, Taxation Section:  Proposed Expansion of Category of Registered Deemed-Compliant FFI: “The Good Faith Local FFI” and the Accidental American along with Liliana Menzie that describes the high concentration of U.S. citizens throughout the region.  “Latin America, as a prime example, has a high concentration of U.S. citizens residing in various countries pursuant to the State Department data, in some cases representing a large percentage of the population (e.g., nearly one half of a percent -0.4%- of the total  population of the Americas consisted of U.S. citizen[s] . . .”

 

Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”). Sound like a non-sequitur?

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Why a non-U.S. citizen may wish to be a U.S. income tax resident (“U.S. person”).  Sound like a non-sequitur?

Normally, anyone residing outside the U.S. is far better off if they are NOT a “U.S. income tax resident.”  This is for several reasons:

  • Plus, those who are married to a non-U.S. citizen have to review and understand in detail the laws of their country of residence, regarding property rights of spouses, whether a spouse is a manager or officer of a foreign company, general and special powers of attorney – such as health care powers of attorney, etc., to know if one has a “financial interest” in such foreign accounts, even if they actually have no signature authority over any foreign accounts.  The law  is obligatory in how these definitions broadly include many persons who are not aware of how they can apply.  See, FOREIGN BANK ACCOUNT REPORTS – 2011 REGULATIONS EXTEND RULES TO MANY UNAWARE PERSONS, published in the International Tax Journal.
  • Managers of companies and other legal entities that have an account around the world, may also fall into these unwary traps.

As someone who advises multiple clients before the IRS on FBAR penalties, I have seen many cases where the government will take an approach of levying significant FBAR civil penalties in particular cases, depending upon how the case is handled, the particular facts and who is the IRS revenue agent and their manager.

Now to the point of this post.  Notwithstanding all of the above considerations, some individuals may find it advantageous to be a “U.S. person” for U.S. federal income tax purposes.  See, Section 7701(a)(30) which uses the technical term “U.S. person” and not a U.S. income tax resident.

If a non-U.S. citizen lives predominantly overseas, they nevertheless can elect to be treated as a U.S. person if they spend at least 31 days in the U.S. during that particular calender year and meet other requirements.   Section 7701(b)(4).

Why would an individual prefer to be a U.S. person for U.S. federal income tax purposes, even if they spend little time in the U.S.?  There could be several reasons.

  • If the non-citizen has a U.S. citizen spouse, they may have a better overall U.S. income tax result (i.e., lower federal income taxes) by filing married filing jointly?
  • If the non-citizen has no significant overseas assets or accounts, they may be able to otherwise avoid the labyrinth of rules under the BSA.